Iraqi Minister's Downfall Hurts Prospect for Financial Bailout

Last week's dismissal of Iraqi Finance Minister Hoshiyar Zebari, the latest convulsion in Baghdad's increasingly unstable politics, risks delaying billions of dollars in badly needed budget support from international lenders and investors.

Parliament dismissed Zebari, a prominent Kurdish official who served previously as foreign minister for more than a decade, after questioning him over alleged corruption and mishandling of public funds.

Zebari denied the charges as "vengeful, politicized and short-sighted", accusing former prime minister Nuri al-Maliki of orchestrating his ouster in a bid to topple the government of Prime Minister Haider al-Abadi.

The political infighting comes as major OPEC producer Iraq struggles to fill a public deficit left by the collapse in global prices for its crude exports.

It is yet another senior vacancy for Abadi's government, which also has no defense minister or interior minister, even as it is preparing for its biggest battle yet to recover territory captured by Islamic State, with a U.S.-backed assault on the jihadist bastion of Mosul expected in coming months.

To replace missing oil revenue, Iraq has turned to the International Monetary Fund for a loan package, which would also serve as the basis for other lenders to provide support.

The IMF approved a three-year, $5.34 billion standby loan in July, in exchange for a package of economic reforms. Baghdad hopes that will unlock more than $12 billion in additional aid from sources such as the World Bank and the Group of Seven leading industrialized nations.

But without Zebari, an avuncular fluent English speaker well respected in international capitals, the Baghdad government loses the figure most closely associated with the deal.

Christian Josz, head of the IMF's Iraq mission, called Zebari "a champion" of the standby agreement.

"He was a big driver behind the reform, and now we don't know who is going to take over from him," Josz told Reuters in a phone interview. He said negotiations would continue with Zebari's eventual replacement, once named: "The IMF has programs with countries, not individuals."

An initial tranche of $640 million was dispersed in July, but the next tranche of equal value depends on a first review. That could happen as early as mid-November but may be delayed while Iraq gets its house in order.

Revising the draft budget that Iraq presented to the IMF last month is key, said Josz.

"It was too expensive, not in line with the commitment in the standby arrangement," he said. "We need to see eye-to-eye on the 2017 budget."

Josz said he expected an update from the Iraqis during a regular IMF meeting in Washington early next month. The government said on Tuesday it was cutting 2017 expenditures to 90.22 trillion Iraqi dinars ($77.51 billion).

The IMF meeting will be a "crux point", said a Western diplomat in Baghdad who closely monitors Iraq's economic affairs.

"Can they get themselves back in order and deliver things by then? If I were to put a bet on it, I would say it would be delayed at the very least but it probably will just be a delay."

Changing ministers in the middle of an IMF program would not necessarily pose a significant obstacle by itself, but Iraq's deal is just taking effect and many of the reforms were driven by Zebari himself, said the diplomat.

"If they're struggling to do that (implement reforms) already and then you get rid of Zebari who was a main proponent of a lot of this, it's just going to delay it."

Baghdad has also said it would boost its finances by selling a $1 billion bond with full guarantee of the United States and a $1 billion Eurobond in the last quarter of 2016.

Those plans could now be in jeopardy.

"With Hoshiyar gone, everything is up in the air," a source familiar with the matter told Reuters, using Zebari's first name.

Yet potential investors remain optimistic. Kaan Nazli, senior economist for emerging markets debt at Neuberger Berman in the Hague, said Iraq was now well-placed to issue debt even if the IMF deal is delayed, because a reform structure is now in place and oil production was boosted this year.

"They would be in a position to go to the investors and present a balance sheet that they can meet the financing gap, and then for the difference they can go to the market," said Nazli. He predicted bonds would yield below 10 percent, compared to the 11 percent investors sought during a government roadshow last year, which Baghdad decided was too much to pay.

His firm holds some of the last international debt Iraq sold in 2006, when it issued about $2.7 billion of bonds due in 2028 with a coupon of 5.8 percent.

Political risk consultancy Eurasia Group forecasts Zebari's impeachment will have a short-term negative impact but the IMF will remain committed to its standby agreement.